FSA Seeks to Overhaul Hedge Funds

Financial News, October 6, 2002 | Go to article overview

FSA Seeks to Overhaul Hedge Funds


Byline: Caroline Allen

The Financial Services Authority (FSA) has a discussion paper in circulation on possible future regulation of the hedge fund industry. Another, on the practice of short-selling, is just about to be released. The implication is that this niche of the investment management industry is going to experience some changes in the months and years ahead.The FSA insists that its approach is risk-based - that is, it is not seeking regulation for its own sake, but as a response to its statutory obligation to ensure stability in the financial markets. Any future moves will be subject to a cost-benefit analysis, although the FSA is also aware of its responsibility to allow innovation in financial markets.

Despite such reassurances, some in the investment management industry feel closer regulatory scrutiny is a delayed impact from the collapse in 1998 of the New York firm Long Term Capital Management (LTCM), which threatened the global financial system, and more recently, allegations that short-selling, widely used by hedge funds, has been responsible for greater than usual market volatility.

However, the FSA points out that kind of risk is associated with what it calls Highly Leveraged Institutions, rather than the overwhelming majority of smaller hedge funds. Global regulators brought in to examine the reasons behind the LTCM debacle pointed the finger of blame more at credit institutions involved than the fund managers. Short-selling, it adds, is practised by all kinds of financial institutions.

Michael Robarts, an associate at consultants Hewitt Bacon & Woodrow, believes the FSA response is appropriate. "Stock lending is an important activity and they are right to say it should not be prohibited. If it were, there would be many ways to get round it, not least by moving everything offshore. Hedge fund activity simply brings the market to the level it would have reached anyway. Companies go bust because the business is wrong, not because the share price is falling."

What is certainly true is that the FSA feels an overhaul of the industry is necessary to match international best practice. Part of the problem, acknowledged by the FSA and practitioners alike, is that hedge funds are not homogenous, with 6,000 vehicles and a dozen strategies deployed in different ways, requiring a variety of regulatory responses.

John Hastings, a partner in the investment consulting practice at Hymans Robertson, says: "Most regulatory regimes have always had funds that were more loosely regulated and open to professional investors only. The regulator ensures this by raising the minimum subscription amount required - often it is $1m (e1m) or more."

Worldwide, hedge funds remain popular with wealthy individuals, endowment funds and family offices, and are generally managed by professional investors. Most regulators are content to leave such sophisticated players to look after themselves. It is when hedge fund strategies are offered to smaller retail investors that interest in extra controls is provoked.

In the UK, the FSA clearly feels that extra surveillance and transparency should be an opportunistic cost to accessing this market. The very idea of the FSA relaxing rules on the marketing of hedge fund products to retail investors came as something of a surprise to some investment managers.

But Bridget Cleverly, managing director of Matrix Money Management, which packages and distributes hedge fund products, says it is long overdue: "It's a very good idea to allow certain types of hedge fund into the UK, which is just following what has happened in other markets like Singapore, Hong Kong and Italy. …

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